Problem with Vertical Integration and Cloud Services

What if Boeing got into the business of delivering air transport services such as passenger travel and cargo?

Before I go into what a terrible idea this would be, lets start with the advantages.

Boeing designs, builds and manufactures planes therefore they can acquire what, typically is, the highest capital cost item an airline would need at cost (lease is a capital cost in my book). Boeing’s gross margin sits between 16% and 19.5%. This gross margin would be their capital cost discount allowing them to walk in with a lower investment hurdle rate per plane and realize a faster ROI.

Because they build and design their own planes, no one is in a better position to maintain and service their fleet. This would translate into higher efficiency and accuracy thus decreasing costs and preventing the loss of money through maintenance mistakes.

Does Boeing know anything about starting and operating an airline? You bet they do! A little known fact, Boeing has a consulting division called StartupBoeing. This group provides a variety of services to help start a new airline or run a profitable one. They provide information and consultancy on operating an airplane, market analysis, International standards for commercial aviation, business planning, airplane selection and airplane sourcing. Clearly a move into the delivery of air transport services by Boeing isn’t that far of a stretch, or is it?

What is the downside?

While they can acquire airplanes at an average discount of 18%, the actual savings is considerably less. In a typical airline carrier company, aircrafts represent 8% of the overall cost structure; with an 18% reduction of an 8% cost nets a 1.5% savings. A 1.5% savings to the bottom line is always welcome but at what cost?

According to The Economist, “[Boeing] delivered a record 648 aircraft to airline [partners] in 2013, with 5,080 orders outstanding at the end of December.” That is an impressive number and an, even more, impressive order backlog. They can’t make them fast enough! What’s more impressive, this is happening at a time when the Macro Global Economy has not quite reached ‘cruising altitude with the seatbelt sign turned off’.

The recently launched Boeing 787, boasts a fuel efficiency savings of 20%. With airline fuel representing 30% of the cost structure this translates into on overall savings of 6% for Boeing’s airline partners. In 2013, the airline industry net profit margin averaged 1.8%; a 6% improvement due to fuel savings would make an enormous impact on shareholder value, especially in light of increasing fuel costs.

If Boeing would enter into the business of delivering air transport services such as passenger travel and cargo, the company might see a short-term boost to the top and bottom line but this would turn a vendor into a competitor to the very partners/customers who are represented in that 5080-order list. With this size of a pipeline, Boeing would need to deliver, globally, at least double that number in cargo and consumer routes to make up for the loss of business in the long run. Programs like StartupBoeing would suffer the consequence of no longer being the trusted advisor to it's partners/customers due to their holding company being a competitor.

While this is not happening in the aircraft business and for good reason, this type of vertical integration is taking place in the IT industry however NetApp is in the unique position of not doing this. Like Boeing, we are fully invested and dependent on the success of our Service Providers, System Integrators and Value Added Resellers. Just as Boeing gains from the success and proliferation of Airline Carriers, NetApp gains from the success of its partners.

NetApp have both the technology and business model which enable Service Providers, System Integrators and Value Added Resellers to be successful. This is done through the innovation and design of data storage and management, products and solutions allowing NetApp's partners, the uninhibited, delivery of the best possible IT and Cloud Solutions for Enterprise customers.

**Note: Some folks have asked me about the picture above: This was photographed on the latest Boeing 787 Dreamliner from the forward mid section looking back towards the tail with none of the interior furnishings; a beautiful sight.